| Cost accounting is the process of tracking, | | | | commissions or casual workers) and very high |
| recording and analyzing costs associated with | | | | fixed costs (interest payments, salaries, |
| the products or activities of an | | | | insurance). |
| organization, where cost is defined as | | | | |
| 'required time or resources'. Costs are | | | | As a result, the terms "direct costs" and |
| measured in units of currency by convention. | | | | "indirect costs" often replace the variable |
| Cost accounting could also be defined as a | | | | fixed terminology, to better reflect the way |
| kind of management accounting that translates | | | | allocation of overhead is actually |
| the Supply Chain (the physical movement of | | | | calculated. Indirect costs (often large) are |
| products) into financial value to support | | | | usually allocated in proportion to either |
| decision making to improve costs and cash | | | | direct costs, or some physical resource |
| flows. | | | | utilization. |
| | | | |
| There are at least four approaches: Standard | | | | One effect of the above is that the practice |
| Costing, Activity-based Costing Marginal | | | | of allocating fixed costs has a far more |
| Costing Throughput Accounting Origins Costs | | | | distorting impact on unit cost figures than |
| were originally considered fixed. | | | | it ever used to have. |
| | | | |
| ("Cost" comes from a Latin root meaning "to | | | | For example: say the railway coach company |
| stand".) In larger organizations, some costs | | | | paid its workforce a fixed monthly rate of |
| tend to remain the same even during busy | | | | $8000 (total) and its other fixed costs had |
| periods, while others rise and fall with | | | | risen to $2600/ month making the total fixed |
| volume of work. A more convenient way of | | | | costs = $10600/month. The unit cost to make |
| categorizing these costs is to define them as | | | | 40 coaches per month is still $325 per coach |
| either fixed or variable. Fixed costs were | | | | ($60 material + (10600/40)), while 100 |
| associated with the business administration, | | | | coaches would have a unit cost of $166 per |
| and did not change during quiet or busy | | | | coach ($60 + ($10600/100)), and 10 coaches |
| times. | | | | would "cost" $1120 each. Managers using the |
| | | | unit cost figure based on 20 coaches per |
| Variable costs were associated with | | | | month ($60 + ($10600/20) or $590) would |
| productive work, and naturally rose and fell | | | | likely reject an order for 100 coaches (to be |
| with business activity. | | | | produced in one month) if the selling price |
| | | | was only $300 per unit. If they used the |
| In the early twentieth century, as | | | | original fixed/ variable cost distinction, |
| organizations began getting more complex, | | | | they would see clearly that this order |
| managers needed a simple way to make | | | | contributes to the fixed costs by $240 per |
| decisions about products and pricing. | | | | coach ($300 - $60 materials) and would result |
| | | | in a net profit of $13,400 (($240 x 100) - |
| Since most costs at the time were variable, | | | | 10600). |
| managers could simply total the variable | | | | |
| costs for a product and use this as a rough | | | | Activity-based costing Activity-based costing |
| guide for decision-making. | | | | (ABC) is costing by activities. In this case, |
| | | | activities are those regular actions |
| For example: In order to make a railway coach | | | | performed inside a company. "Talking with |
| a company needed to buy $60 in raw materials | | | | customer regarding invoice questions" is an |
| and components, and pay 6 laborers $40 each: | | | | example of an activity performed inside most |
| total average variable costs of $300. Knowing | | | | companies. |
| that making a coach required spending $300, | | | | |
| managers therefore couldn't sell below that | | | | Accountants assign 100% of each employee's |
| price without losing money on each coach. Any | | | | time to the different activities performed |
| price above $300 became a contribution to the | | | | inside a company (many will use surveys to |
| fixed costs of the company. If the fixed | | | | have the workers themselves assign their time |
| costs were, say, $1000 per month for rent, | | | | to the different activities). The accountant |
| insurance and owner's salary, the company | | | | then can determine the total cost spent on |
| could therefore sell 5 coaches per month for | | | | each activity by summing up the percentage of |
| a total of $3000 (priced at $600 each), or 10 | | | | each worker's salary spent on that activity. |
| coaches for a total of $4500 (priced at $450 | | | | |
| each), and make a profit of $500 in both | | | | Each product or service is produced and |
| cases. | | | | delivered via the activities performed in the |
| | | | company. The accountant can then assign the |
| Standard costing Standard costing took the | | | | different activities to the different |
| idea further, by dividing the fixed costs by | | | | products using an appropriate allocation |
| the number of items produced, and treating | | | | method. |
| the result as if it were a variable cost. | | | | |
| | | | A company can use the resulting activity cost |
| This enabled managers to effectively ignore | | | | data to determine where to focus their |
| the fixed costs, simplifying the decision | | | | operational improvement efforts. |
| process even more. | | | | |
| | | | For example, a job based manufacturer may |
| For example: if the railway coach company | | | | find that a high percentage of their workers |
| produced 40 coaches per month, and the fixed | | | | are spending their time trying to figure out |
| costs were still $1000/ month, then each | | | | a hastily written customer order. Via ABC, |
| coach could be said to incur an overhead of | | | | the accountants now have a currency amount |
| $25 ($1000/40). | | | | that will be associated with the activity of |
| | | | "Researching Customer Work Order |
| Adding this to the variable costs of $300 per | | | | Specifications". |
| coach produced a unit cost of $325 per coach. | | | | |
| | | | Senior management can now decide how much |
| This method tended to slightly distort the | | | | focus or money to budget for the resolutions |
| resulting unit cost, but in mass-production | | | | of this process deficiency. |
| industries that made one product line, and | | | | |
| where the fixed costs were relatively low, | | | | Activity-based management includes (but is |
| the distortion was very minor. | | | | not restricted to) the use of activity-based |
| | | | costing to manage a business. |
| For example: if the railway coach company | | | | |
| made 100 coaches one month, then the unit | | | | Marginal Costing This method is used |
| cost would become $310 per coach ($300 + | | | | particularly for short-term decision-making. |
| ($1000/100)). If the next month the company | | | | Its principal tenets are: Revenue (per |
| made 50 coaches, then the unit cost = $320 | | | | product) - Variable Costs (per product) = |
| per coach ($300 + ($1000 /50)), a relatively | | | | Contribution (per product) Total Contribution |
| minor difference. | | | | - Total Fixed Costs = Total Profit / (Total |
| | | | Loss) Thus it does not attempt to allocate |
| i.e. unit cost is inversely proportional to | | | | fixed costs in an arbitrary manner to |
| no. of variables. | | | | different products. The short-term objective |
| | | | is to maximise contribution per unit. If |
| Evolution of standard costing As time went | | | | constraints exist on resources then under |
| on, the practice of paying workers on a | | | | marginal costing, these resources to maximise |
| 'set-piece' basis changed in favour of paying | | | | contribution per unit of the constrained |
| on an hourly rate. | | | | resource. |
| | | | |
| Organizations with a wide range of products | | | | Other costing methods More varieties of |
| or services have many tasks common to several | | | | costing methods have been proposed in order |
| finished items,making set-piece impractical. | | | | to tailor for different aspects of the |
| | | | business. Some of the uprising ones include |
| Costs of materials may vary over time. | | | | inventory costing method, process costing |
| | | | method, average costing method, target |
| Equipment has become more complex and | | | | costing method. |
| specialized and may be a significant variable | | | | |
| in overhead costs. | | | | Still the standard methods and normal costing |
| | | | methods are the best established methods in |
| Modern companies tend to have relatively low | | | | the accounting world. |
| truly variable costs (primarily raw material, | | | | |